WRAPUP 10-New dispute threatens U.S. debt limit negotiations

* Congress drafting legislation, wants plan by Monday

* Major disagreement threatens effort: Sen. Reid

* Treasury out of money on Aug. 2; AAA rating at risk

* Default would raise interest rates, hit global growth

* Congress aims to show progress before Asian markets open (Recasts, adds quotes and details)

By Alister Bull and Donna Smith

WASHINGTON, July 23 (Reuters) - New disagreement erupted late on Saturday between congressional Democrats and Republicans over the timetable for increasing U.S. borrowing authority, possibly jeopardizing efforts to avert a default.

Democratic and Republican leaders escalated their fight despite instructions from President Barack Obama earlier to produce a budget plan by Monday that would clear the way for Congress to raise the $14.3 trillion debt ceiling by Aug. 2.

Saying he was "deeply disappointed" by the lack of progress toward a deal to raise the credit limit built around deficit cuts, Senate Democratic leader Harry Reid said Republican "intransigence" was "pushing us to the brink of a default on the full faith and credit of the United States."

The latest flare-up centered around a Republican plan being proposed behind closed doors calling for two installments of debt limit increases and deficit reduction.

Democrats said they only wanted to extend the debt limit once through the 2012 election year, a Democratic aide said.

Democrats insist upon tax increases as part of deficit reduction and fear that under the Republican plan they would be put off until next year in the midst of presidential and congressional re-election campaigns, or may be never happen.

Michael Steel, a spokesman for House Speaker John Boehner, the top Republican in Congress, said that "a two-step process is inevitable." He also reiterated that a default "is not an option."

Lawmakers nevertheless scrambled despite the new wrinkle to show by around 4 p.m. EDT Sunday -- just before Asian markets kick off their trading week -- that substantial progress was being made to avoid a U.S. default on its debt.

A Republican leadership aide said lawmakers are working on a plan for $3 trillion to $4 trillion in savings over 10 years, but another high-ranking Republican official said no numbers had been set.

Talks between Obama and Boehner collapsed in acrimony on Friday. In hopes of patching things up, Obama called Boehner, Reid, Senate Republican Leader Mitch McConnell and House Democratic Leader Nancy Pelosi to the White House early on Saturday to discuss a path forward.

The four congressional leaders met in the Capitol later in the day as work got hung up on the question of whether to go for a long-term or shorter-term debt limit hike.

The lawmakers' overall goal: Seal a deficit-reduction package of spending cuts and perhaps tax increases that will allow a vote by the August deadline to raise the U.S. debt ceiling beyond $14.3 trillion and avoid potential economic calamity.

Financial markets are growing more edgy and U.S. banks and businesses are making contingency plans for the possibility of a debt default that would drive up interest rates, sink the dollar and ripple through economies around the world.

Credit rating agencies want spending restraints for the United States to keep its prized Triple-A rating, which makes U.S. Treasuries the solid foundation for global investors and lowers borrowing costs for state governments, businesses, homeowners and consumers.

Investors followed developments throughout the day.

"We continue this weekend to monitor very closely the negotiations in Washington, with frequent updates and assessments. We are also evaluating reactions outside the United States," Mohamed El-Erian, co-chief investment officer at Pacific Investment Management Co., told Reuters.

A breakdown in Washington, he feared, "will be highly detrimental to the already fragile health of both the U.S. and global economies."

Lawmakers also were mindful of what could happen in financial markets if a deal is not quickly reached.

"I am concerned that there might be an adverse reaction in the markets," Republican Representative Charles Dent said in a telephone interview with Reuters.

Dent said Boehner told members a default was not an option and lawmakers have to come to agreement.

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Anything possible if U.S. downgraded [ID:nN1E76I1M8]

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In the White House meeting, Obama warned lawmakers not to pursue a short-term extension of the debt limit.

"Congress should refrain from playing reckless political games with our economy. Instead, it should be responsible and do its job, avoiding default and cutting the deficit," White House spokesman Jay Carney said after the talks.

A short-term extension of mere months could cause Wall Street credit agencies to strip America of its gold-plated triple-A rating and increase interest rates for American consumers, Obama told them.

WINDOW QUICKLY CLOSING

With the world's biggest economy set to run out of money to pay all of its bills on Aug. 2, the window was closing fast for a "grand bargain" of spending cuts and tax increases in exchange for Congress raising the debt ceiling.

The fits and starts in the negotiations have left both sides fuming. Obama has said he has agreed to deep spending cuts in social programs that make his own Democrats uneasy but that Republicans must allow some taxes to rise, a prospect they have rejected.

Before talks between Obama and Boehner collapsed Friday largely over how much revenue would be raised through tax reform -- with Obama wanting $1.2 trillion over 10 years and Boehner putting $800 billion on the table.

Boehner has to overcome resistance from Tea Party movement conservatives in his own party and could run into problems for having signaled a willingness to give ground on revenue increases in closed-door talks at the White House. (Additional reporting by Richard Cowan; Writing by Steve Holland; Editing by Eric Walsh and Todd Eastham)